Quarterly Update

The second quarter of 2019 (Q2) seemed full of continued trade-related market volatility and speculation about interest rates. Both categories each sent the markets down and then up again during the quarter. While May saw stocks fall 6+%, the quarter ended on a high note brought on by, you guessed it, more news about trade and interest rates.

Here’s a summary of how major market indexes ended the quarter and year-to-date, respectively (as a reminder, the YTD numbers look very strong, but this is off deep lows in December):

• S&P 500: up 4.3%, up 18.5%
• Russell 2000 (small company stocks): up 2.1%, up 17%
• MSCI EAFE (foreign stocks): up 4%, up 14.5%
• MSCI EM (emerging markets): up 0.7%, up 10.8%
• U.S. Aggregate Bonds: up 3.1%, up 6.1%

The financial sector was the top performer during Q2, showing growth of about 8%. Technology continued its strong performance and is the best performing sector this year, up about 27% YTD. Energy stocks performed poorly, down about 3% during the quarter. Although the sector performed well during June as oil prices rose to the high-$50’s per barrel, it wasn’t enough to make up for poor performance during April and May. Gold was up as well, about 10% YTD with almost all that performance happening in June.

As has become all too familiar lately, trade rhetoric and geopolitical concerns caused a lot of market volatility during Q2, both positive and negative. April and May saw more tweets from President Trump about potential new tariffs directed at China followed by a short-term tariff-related row with Mexico. The latter ended up fizzling but was enough to add a layer of uncertainty to markets already digesting the resignation of the British PM after failing to deliver Brexit. Much of this tension eased, however, as we entered June and markets took off for the remainder of the quarter.

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Adding to the back and forth were expectations for interest rate cuts from the Fed. Briefly in March and then more meaningfully during Q2, the “yield curve” inverted. The yield on the 10yr Treasury note was about 2% for much of May and June compared with the 3mo Treasury yielding about 2.14%. Since longer-term bonds normally yield more than short-term, this situation is a classic indicator of coming recession. Historically, the curve has been inverted for at least 30 days, but typically over 50 days, before being a more solid recession indicator. We’ve crossed the 30-day mark and time will tell how long the inversion lasts from here.

The inverted yield curve helped cause the downward market slide in May as recession fears piled onto an already nervous investor’s mind. But then in June, even though the curve was still inverted, the mood shifted as investors began assuming the Fed would have to lower interest rates soon to help buoy the economy. Currently, bond investors are pricing in a 100% “chance” the Fed cuts rates at least .25% at its meeting later this month. Also priced in are a couple more cuts the rest of this year.

This changing thinking about Fed policy turned the bond market on its heels during Q2. High quality bonds ended the quarter up about 6% YTD with about half that performance occurring within late-May and June. This is an example of the double-edged sword of the bond market. These returns help your bottom-line performance but are also an indicator of bad weather on the economic horizon.

Surging stock and bond prices based on assumptions about reduced trade tensions and Fed rate cuts should make reasonable investors nervous. The stock market loves lower interest rates as this, generally speaking, helps stimulate the economy. And news reports at the end of Q2 suggest that trade tensions could ease. Both would be a continued boon for stocks. But it’s important to set these headlines against a backdrop of a global economy that’s starting to show some signs of weakness.

It might be awhile yet before wider cracks begin to show, but it’s time to think about hunkering down a bit. This can mean taking profits through rebalancing, or even reducing your stock allocation if you’re currently taking regular income from your portfolio.

Have questions? Ask me. I can help.